Our take on the growing headwinds for Canada's housing market

Key Takeaways:

• After years of low interest rates, Canadian mortgage rates have surged to multidecade highs. The unique structure of the Canadian mortgage market, which is comprised largely of variable-rate and shorter-term fixed-rate mortgages (typically five years or fewer), makes households more sensitive to higher rates and more likely to experience rising mortgage bills.
   
• Household debt overall in Canada has risen to a historically elevated level. Residential-mortgage debt now represents over 70% of Canadian GDP, while total household debt represents over 100%.² This could further weigh on housing-market activity and consumer spending in the near term as households may be forced to prioritize debt-service payments over discretionary purchases.
   
• Despite elevated household debt and high mortgage rates, strong Canadian population growth and potential interest-rate cuts from the Bank of Canada over time could offer support for the domestic housing market over the long term. It also highlights the importance of maintaining appropriate allocations to Canadian equities and bonds. However, international allocations could help offset risks in your portfolio from these dynamics within the Canadian economy. In the current environment, we recommend investors underweight Canadian large-cap stocks in favour of U.S. large-cap stocks.

The Canadian housing market is unique

Given the extended and significant rise of the domestic housing market over the past two decades, housing investment in Canada has become a material contributor to the overall economy. Residential-mortgage loans now total about C$2.2 trillion, equivalent to around 75% of Canadian GDP (gross domestic product), compared with under 40% in the early 2000s.² Nearly 60% of Canadians own homes, and among these homeowners, about 60% have mortgages.¹ Compared with a market like the U.S., where the average home loan is a 30-year fixed-rate mortgage, the majority of mortgages in the Canadian market are either variable-rate or fixed-rate with shorter terms (usually five years or fewer). This housing-market structure also poses some risk to the Canadian economy, particularly given the rise in interest rates over the past two years. With domestic mortgage rates at 15-year highs, downward pressure on consumer spending (the biggest driver of GDP growth), housing investment may continue to increase, given that more homeowners face rising mortgage bills, as mortgage rates reset higher, or mortgages are rolled over at higher rates.²

Figure 1. The Canadian mortgage market is made up largely by variable-rate and shorter-term fixed-rate loans

Figure 2: Canadian residential mortgages now represent over 70% of nominal GDP, compared with about 40% in the 1990s

Impact on households and the economy as mortgage rates rise

Given that the Bank of Canada (BoC) has raised interest rates 10 times since March 2022, mortgage rates in Canada have climbed substantially, averaging about 6.2% in January 2024, versus around 2.0% in early 2022.¹ The recent rise in mortgage rates has implications for both Canadian households and the broader economy.

Concerning households, debt overall has increased, and mortgage debt-service ratios, or the amount that households spend on mortgage payments relative to their disposable income, have risen to their highest on record. Altogether, Canadian mortgage debt payments have risen from $95 billion in the second quarter of 2020 to over $146 billion in the fourth quarter of 2023 – a 54% increase in just three years. The interest portion of household mortgage debt payments has nearly doubled since the first quarter of 2021, rising from $49 billion to $97 billion. Additionally, interest payments represented about 66% of overall household mortgage payments in the fourth quarter of 2023 compared to 46% in the fourth quarter of 2021.¹ This sharp jump has led to households spending more on paying down their home mortgages and perhaps less on other discretionary purchases. We see evidence of this in household consumption expenditure data, which grew by a modest 1.7% year-over-year in 2023, down from the 2022 reading of 5.1%.² Canadian retail sales also slowed in 2023, rising by 2.2% year-over-year compared to 8.3% in 2022. This comes at a time when savings rates in Canada are near post-pandemic lows.² The elevated mortgage-rate environment may continue to put pressure on both household savings and consumption in the near term.

Figure 3. Canadian households are spending a record percent of disposable income on paying their mortgage

From a macroeconomic perspective, the housing market in Canada overall has cooled. Housing investment now represents around 7.5% of nominal GDP, down from the peak of over 10% in 2021, but above the long-run average of roughly 6%.² Additionally, the housing component of real GDP has contracted on a quarter-over-quarter basis in six of the last seven quarters through the fourth quarter of 2023.² New-home price appreciation has turned negative year-over-year, and housing starts and residential building permits have declined from peak levels.² Despite these declines, home affordability in Canada remains depressed, as mortgage rates and household debt have risen, potentially putting further pressure on home prices.

As a result, the economies built around the housing market, including construction, home furnishings and home loans, may face some easing demand as well. And the financial firms and banks that offer mortgage loans could see some rise in delinquencies and softer loan demand overall – something to watch for in the months ahead.

The housing market may falter, but there are some stabilizers ahead

While we would expect continued softness in the Canadian housing market in the near term, we don’t anticipate deep or prolonged distress in the housing system, certainly not like we saw back in the U.S. housing market during the 2008 financial crisis. In fact, we see a couple of important reasons for stability and perhaps recovery ahead.

First, the Canadian population has been growing since the pandemic period, supported by steady immigration into the country. In fact, the 3.2% year-over-year population growth in the fourth quarter of 2023 was the highest since 1957.² This growing population will seek both housing and home loans, which supports demand for homes over the longer term and helps to put some floor on home prices as well.

Canadian population growth has been rising, driven in part by steady immigration

Second, and perhaps most important, the Canadian interest-rate environment has likely peaked and may be heading towards a gradual move lower over the course of the year. In our view, the BoC is likely to begin cutting interest rates in 2024. The Canadian economy has shown signs of fatigue and inflation has trended lower toward the BoC's 1-3% target. The potential for BoC rate cuts and lower mortgage rates later in 2024 could provide a welcome catalyst for housing market activity.

Nonetheless, after years of low rates, Canadian consumers have made substantial investments in their homes, and historically elevated mortgages and debt overall are significant concerns. At the end of 2023, household debt represented about 180% of disposable income. Stated differently, there is roughly $1.80 of household debt for every $1 of household disposable income.¹ While a gradual move lower in rates would alleviate some of the pressures, it could take months or years for household leverage to come down, and consumption may remain restrained through this process.

Action for investors

We would expect elevated mortgage rates and a cooling Canadian housing market to weigh on household consumption in the near term, which would put downward pressure on economic growth. The structure of Canadian mortgages versus the U.S. market, for example, leaves the Canadian housing economy relatively more susceptible to elevated and volatile interest rates. We may see opportunities emerge as mortgage rates stabilize and potentially move lower, providing support to housing and the broader Canadian economy. Therefore, it's important to maintain allocations to Canadian investments, but to also diversify in U.S. and overseas markets to offset domestic economic and market risks. In the current environment, we recommend investors underweight Canadian large-cap stocks in favour of U.S. large-cap stocks.

For households, we recommend working with your financial advisor to help ensure you have a strategy in place to address potentially rising mortgage and debt costs, while staying on track to meet your long-term financial goals. Keep in mind that investing in a home offers utility and function beyond simple financial returns and can form a foundation for our day-to-day lives. Despite the headwinds, home ownership can also complement traditional investment portfolios and offer diversification and the potential benefits of investing in a real asset over the long term. For strategies to consider as you approach a renewal of your home mortgage, please refer to: Mortgage renewal | Edward Jones

Mona Mahajan
Investment Strategist

Brock Weimer, CFA
Associate Analyst

^{Source: 1. Statistics Canada, Edward Jones. 2. FactSet. Edward Jones.}